Public Bill Committee

[Mr. Jim Hood in the Chair]

(Except clauses 7, 8, 9, 11, 14, 16, 20 and 92)

Clause 40 ordered to stand part of the Bill.

Schedule 19

Income tax credits for foreign distributions

Ian Pearson: I beg to move amendment 158, in schedule 19, page 201, line 2, leave out from fund to end of line 3.
Good morning, Mr. Hood. It is a pleasure to serve under your chairmanship in this, the ninth sitting of the Finance Bill Committee.
Amendment 158 was tabled by my right hon. Friend the Financial Secretary and the hon. Member for Fareham, so I think that it will prove to be uncontroversial. The amendment will delete an inconsequential signpost attached to condition B of proposed new section 397AA to the Income Tax (Trading and Other Income) Act 2005, which was included to help taxpayers to interpret the legislation by alerting them to the changes made in clause 39. However, it has been suggested that the wording could be misinterpreted. To remove any doubt, the amendment will remove the wording in question.

Amendment 158 agreed to.

Mark Hoban: I beg to move amendment 169, in schedule 19, page 202, line 15, leave out from 397AA to end of line 18.
I hope that this amendment will sail through as easily as the first one that we debated this morning. However, as the Financial Secretary has not appended his name to it, I suspect that it will run into heavier water.
Since 6 April 2008, individual shareholders with holdings of less than 10 per cent. in non-UK-resident companies have been entitled to a non-payable dividend tax credit. However, that tax credit was disapplied for dividends received from offshore funds in the Finance Act 2008, to counter the inequality of treatment of distributions received from onshore and offshore bond funds. Schedule 19 will restore the non-payable dividend tax credit for distributions received from corporate offshore funds that are largely invested in equities.
The 10 per cent. ownership threshold is removed for dividends paid by offshore funds, subject to anti-avoidance rules. However, when an offshore fund invests more than 60 per cent. of its assets in interest-bearing assets, or those that are economically similar, individuals receiving distributions will be treated for tax purposes as having received interest income and not a dividend or other type of distribution. As a result, no tax credit will be available and the tax rates applied will be those that apply to interest. Those rules will have effect from 22 April 2009. That starting date is the subject of amendments 167, 166 and 168, which are in the next group.
Amendment 169 relates to the provision of tax credits to individuals in receipt of dividends in non-UK resident companies, subject to certain provisions. Under the new provisions, a tax credit will be made available to shareholders in a company resident in a qualifying territory. The amendment would give certainty that, once a territory is designated as a qualifying territory and has passed the legislative test, the Treasury will not be able by regulation to disqualify it. The amendment would provide greater certainty for taxpayers that, once a qualifying territory has passed the legislative test, there can be no subsequent change to its status.

Ian Pearson: The Government take a different view of amendment 169. We believe that it would remove one of the anti-avoidance provisions that we are making in new section 397BA of ITTOIA. The purpose of this part of the legislation is to provide the Treasury with the flexibility to change the classification of an otherwise qualifying territory to non-qualifying, so that the UKs tax system can reflect and respond to future changes in foreign tax systems. It would, for example, allow the Government to respond to the development of a new regime in a tax haven.
The Government do not intend to exercise the power unless exceptional circumstances arise in which there is a substantial risk of loss to the Exchequer, and any changes would be subject to the affirmative procedure. A similar provision exists in the transfer pricing rules, so the approach is well understood. It has never been necessary to use the provision in the transfer pricing rules, but we believe that it acts as an important deterrent to prevent the most blatant forms of avoidance.

Mark Hoban: For whom does it act as a deterrent? The Minister is referring to changes that may take place in a tax jurisdiction, so will it be a deterrent to a sovereign Government who might want to change their tax rules? Is that an appropriate use of British power?

Ian Pearson: We believe that the legislation is an appropriate use of British power and, as I explained, that the UKs tax system needs to reflect and respond to future changes in foreign tax systems. The hon. Gentleman will be aware of the regimes that may operate in tax havens.
We have never had to use the rule on transfer pricing, but we believe that it has acted as a deterrent. Amendment 169 would remove flexibility and curtail the Governments ability to respond to changes in tax systems abroad, so I ask the hon. Gentleman to withdraw the amendment.

Mark Hoban: One of my predecessors as Member of Parliament for the area of Hampshire that I represent was Lord Palmerston, who was a great believer in gunboat diplomacy, as well as the builder of Palmerstons folly across the top of Portsdown hill. I thought that the days of gunboat diplomacy had passed, but we have here the tax equivalent in a power that is intended to deter sovereign Governments, or perhaps former British colonies, from changing their tax regime. It is curious that the Government should have such a power, that a Minister should suggest that we threaten other Governments with it, and that it should be a deterrent. The provision suggests that there may be a more martial spirit in the Treasury than we suspected.
I take on board the fact that the power has not been used in the transfer pricing regime, and that it will be subject to the affirmative procedure. I am sure that tax havens are quaking in their boots because the measure has been included in the Bill. I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Mark Hoban: I beg to move amendment 166, in schedule 19, page 204, line 14, leave out 22 and insert 6.

Jimmy Hood: With this it will be convenient to discuss the following: amendment 167, in schedule 19, page 204, line 16, leave out 22 and insert 6.
Amendment 168, in schedule 19, page 204, line 18, leave out 22 and insert 6.

Mark Hoban: Having disposed of the threat from sovereign Governments, we now come to the threat from taxpayers. The amendments are relatively simple, and would replace 22 with 6. Hon. Members who have not perused the detail of the schedule may wonder why I tabled the amendments.
The changes in schedule 19 apply from the date of the Budget, but some tax advisers suggested that it would be better if the rules were applied from the start of the tax year. That would be advantageous for taxpayers because the rules applying from 22 April are better than the previous rules. There was some surprise among tax advisers that the measure was not made effective from 6 April 2009, in line with the announcement in the 2008 Budget, on which taxpayers may have relied.
The Chartered Institute of Taxation has noted that the draft legislation published in January 2009, which continued to be available on the HMRC website until 16 May last month, included the proposal that these changes should
have effect in cases in which a relevant distribution arises, is paid over or is treated as paid in the tax year 2009-2010.
When the Bill was introduced, there was some surprise that it had the date of 22 April in it. I know that that question was raised during the Finance Bill open day, when CIOT asked:
Will the new measure to extend the entitlement to a non-payable dividend tax credit to individuals with holdings of 10% or more be made effective from 6 April 2009 rather than 22 April 2009 in line with the previous announcement in Budget 2008 upon which taxpayers may have reasonably relied?
It went on to ask whether HMRC will be able to able to grant concessionary treatment to someone who in good faith has relied on last years Budget announcement.
The argument that HMRC used at the time was that the announcement was only general and should not have been relied upon by taxpayers. Normally, the Budget would have been expected to have taken place in March and the change would have been effective from 6 Aprilthe start of the tax year. The delay in the Budget has created a disconnect and changed taxpayers reasonable expectation, which werein line with the draft legislation published at the start of this yearthat the commencement date would be the start of the tax year. That would reflect the general statement of intention made by the Government in the Budget 2008 when the changes were outlined.

Ian Pearson: It is true that, as the hon. Gentleman says, the Budget note from last years Budget stated that the extension of the shareholdings of 10 per cent. or more in foreign companies would be made effective from 6 April 2009. It is the convention to make tax changes effective from the beginning of the tax year, and with that assumption date stated in the Budget note was 6 April. However, as he knows, because the Budget did not take place until 22 April, the changes to the non-payable dividend tax credit could not be made earlier without the measure including retrospective legislation. That is why the legislation is effective from 22 rather than 6 April. Given the hon. Gentlemans point that some individuals might have relied on that to determine their tax affairs, HMRC would examine any hard cases on their individual merits, although it cannot offer concessionary treatment.
It is true that, for the legislation to come into effect before the Budget datewhen it was announcedwe would have to have evidence of extraordinary circumstances, such as the existence of damaging tax avoidance. That is not the case in this instance. Also, it is right to recognise that making the measure effective from 6 April could disadvantage some taxpayersfor example, those who were affected by the class of share definitionretrospectively. Again, that is why the Government decided that 22 April should be the date on which the legislation should come in to effect: to ensure that the legislation is compliant with the Human Rights Act 1998.
I have sympathy with the hon. Gentlemans arguments. The issues to which he referred are a result of the Budget being later than normal. I have discussed how HMRC might examine any hard cases on their individual merits, and I hope that with those comments in mind, the hon. Gentleman will seek leave to withdraw his amendment.

Mark Hoban: I am grateful to the Minister for his response, particularly for his comments on how HMRC will look at hard cases. However, the Government clearly set out their intention to apply the changes from the start of the tax year and it was reasonable of taxpayers to assume that that would be the case. Solely for political reasons, with the delay of the Budget, taxpayers lost out. They did not lose out through their own activity, but because of the decision taken by the Chancellor to timetable the Budget for after the G20 summit. The Government should reflect on that, because they havemisled is not the right wordgiven the impression that something would happen from the start of the tax year. That has not happened for political reasons, rather than for any other good fiscal reasons, and that point should be taken on board by the Government.
In the light of remarks made by the Minister regarding the treatment of hard cases, I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Schedule 19, as amended, agreed to.

Clause 41

Loan relationships involving connected parties

Question proposed, That the clause stand part of the Bill.

Mark Hoban: I have just a couple of comments on schedule 20, which the clause introduces. First, a word of praise, which does not come very readily from my lips on these occasions, but there has been some very positive comment on the consultation for clause 41 and schedule 20. That consultation has worked well and improved the schedule. However, one or two issues have been raised with me.
Companies have used the late interest rules to get a tax reduction for interest expenses when they have needed it. That has particularly been the case with part equity-backed businesses. If an interest reduction cannot be used in the current year, it will be carried forward as a non-trade debit that can be offset against non-trade credits. That was not felt to be particularly useful, so companies would therefore trigger the debit when they could use it or needed it. The schedule takes the flexibility away on timing for finance costs.
The Governments counter-argument might be that, as the legislation has been partly introduced for anti-avoidance purposes, that might well be the purpose of removing that flexibility. However, companies could still obtain tax relief when the interest is paid using companies non-qualifying territoriesfor example, Jersey. That means that they cannot refer an accruals basis for tax relief when they need to. Will the Minister comment on the interaction between the schedule and the debt cap rules? Some clarity is required and I would be grateful for his thoughts on how that clarity might be introduced.

Ian Pearson: First, I acknowledge the comments made by the hon. Gentleman on how the consultation was handled. I am sure that that statement will be welcomed by my officials who have undertaken the consultation exercise. He is right to point out that there is widespread recognition for what the Government are doing; there were only some minor points raised regarding the issue of loan relationships involving connected parties.
He pointed to the issue of private equity companies. As he is aware, the legislation contains an election to enable a company to stay on a pay basis for a year after the change. That should give companies time to rearrange loans if they think they need to. The private equity industry has raised some practical difficulties with HMRC, where interest is payable to a company controlled by a number of private equity investors. Those are matters that we believe are best dealt with in guidance and HMRC is discussing them with the private equity industry.

Mark Field: In the current economic circumstances, was any consideration given by the Treasury to extending the period of 12 months? The Minister will be aware that, particularly given the potential difficulty of acquiring funding, it may well be that that period, which might normally seem quite a sensible transition period, will not prove long enough for the reorganisation of finances for private equity companies in this difficult economic situation.

Ian Pearson: Well, we always consider these matters carefully. It is our judgment that a period of 12 months is a reasonable period of time to allow companies to rearrange loans if they need to do so.
The point was made about whether or not an election should be allowed for private equity groups to deduct interest on a paid basis, if they want to. In response, I would say that allowing companies the choice to deduct interest, either when it accrues or when it is paid, would go against one of the key principles of the corporation tax rules on the taxation of interest. Interest is taxable and relievable as it accrues in the accounts. We are not persuaded that an exception needs to be made for private equity. However, HMRC will work with the industry in improving its guidance in this area.
The point about the interaction with the debt cap was made by the hon. Member for Fareham. Specifically on that point, I can say to him in response that ordinary loan relationship rules, such as late interest, are applied before the debt cap applies. That is another matter that we will cover in the guidance.
As I have said before, HMRC is in discussions with the private equity industry about these matters and we believe that they can be satisfactorily addressed through guidance. The industry is happy with that.

Question put and agreed to.

Clause 41 accordingly ordered to stand part of the Bill.

Schedule 20 agreed to.

Clause 42

Release of trade etc debts

Question proposed, That the clause stand part of the Bill.

Mark Hoban: I wish to raise an issue about the clause. The changes in the clause enable transactions between rated parties so that, where there is a waiver of a property or trade debt, these releases will not be taxable in the debtor company nor will there be a tax relief in the creditor company. So, within the group these changes are tax-neutral.
However, there are other inter-company balances that arise other than through trade or property debts. It has been suggested that it might be helpful to enable long-standing inter-company balances to be written off and relief to be given, so that there is no taxable transaction taking place in the debtor company nor is the tax relief given in the creditor company. I just wonder whether the Government have thought about extending the relief to companies in those circumstances.

Ian Pearson: I am not sure that I have a direct answer to the hon. Gentlemans question at this point in time. He will be aware of what we are trying to achieve through the clause. He will also be aware that the clause covers trade and property business debts. He asked why there could not be releases of any money debts between group members and he specifically made the point about the period of time. Covering other sorts of debts, such as those relating to the management expenses of investment companies, would have made the clause considerably longer and more complicated, and the representations that have been made to the Government have not suggested that, in practice, such debts cause as many problems as trade debts. However, we have not ruled out the possibility of further changes in the future. We believe that we have covered most of what needs to be done, but we would be happy to receive further representations from business and the professions about any real life problems involving money debts that are not within the clauses scope.

Question put and agreed to.

Clause 42 accordingly ordered to stand part of the Bill.

Clause 43 ordered to stand part of the Bill.

Schedule 21

Foreign exchange: anti-avoidance

Question proposed, That the schedule be the Twenty-first schedule to the Bill.

Mark Hoban: I have just one question about schedule 21. Paragraph 2 states that
the arrangements cause the company or any other company to gain a tax advantage (other than a negligible tax advantage).
Schedule 21 introduces anti-avoidance provisions, but why is there not a more traditional motive test? Paragraph 2 offers a very broad definition, but when anti-avoidance is involved, one normally expects the more traditional wording where the main purpose involves tax avoidance. Paragraph 2 might cover a much broader range of transactions than would normally be covered by a targeted anti-avoidance measure.

Ian Pearson: This is an important schedule in relation to targeting anti-avoidance. It is designed to stop schemes that involve abuse of the tax rules for what is known as forex matching. A number of such schemes have been disclosed to HMRC, and have been widely used in practice. It is estimated that stopping such avoidance will bring in additional corporation tax of £20 million a year and prevent further losses to the Exchequer of approximately £120 million a year. It is therefore important that we introduce legislation.
The hon. Gentleman has asked why the legislation does not contain a purpose test. Existing provisions in the tax rule for loans and derivatives deny relief for losses where the loan or derivative has a tax-avoidance purpose. Although those provisions may deny relief for losses generated by forex matching schemes, they can involve some very difficult and long drawn-out arguments between HMRC and the businesses concerned. The Bill aims to put it beyond doubt that such schemes do not work, even where they are designed to reduce the risk of a purpose test challenge. The tax avoidance purpose rule would therefore be counter-productive. It would not give certainty to compliant companies, because experience suggests that such companies are likely still to be concerned about whether their purposes could be perceived as unallowable. It might also provide avoiders a loophole through which they could escape, where contemporaneous evidence of a companys purpose is lacking. We considered a purpose test, but there are clear reasons why we deliberately rejected it. Our approach is more robust.

Question put and agreed to.

Schedule 21 accordingly agreed to.

Clause 44 ordered to stand part of the Bill.

Schedule 22

Offshore funds

Question proposed, That the schedule be the Twenty-second schedule to the Bill.

Mark Hoban: I have just a couple of questions about the schedule. The first relates to the clarity of the guidance that has been issued so far on the matter. My second and more substantive concern may seem a curious one for me to raise given my earlier remarks about the way in which the rules on the debt cap and dividend exemption seem to be driven by the EU, and the fact that the Government have assured us that they were robust to challenge. However, it has been suggested that the rules on schedule 22 may not be robust and may be challenged on whether or not they comply with EU rules.
Let me deal with the guidance point first. There is concern that although some guidance has already been issued by HMRC it does not address all the questions raised by industry during the consultation on schedule 22. The grandfathering rules that apply until 1 December 2009 are helpful, but they should address immediate industry uncertainty.
The characteristics-based definition is potentially so wide-ranging that instead of providing greater certainty, it is likely to make the position even more unclear. It is suggested that there may be a range of offshore arrangements that are not, in substance, funds, but that may be subject to the rules. There is concern regarding interpretation around offshore companies fixed lives, shared buy-back arrangements and liquidation exit routes as well as special purpose vehicles under partnership. It may be the Governments intention to ensure that such areas are not caught by schedule 22, but, as they stand, the broad nature of the rules catches those entities.
This schedule introduces into legislation the definition of an offshore fund. It can be
a mutual fund constituted by a body corporate
or
a mutual fund under which property is held on trust for the participants where the trustees of the property are not resident in the United Kingdom
or
a mutual fund constituted by other arrangements that create rights in the nature of co-ownership
where those arrangements are affected by non-UK law. The schedule then sets out some conditions that a mutual fund might need to satisfy to then be defined as an offshore fund. Therefore, some certainty is required. Uncertainty does not only impact on UK investors; it also creates additional complexity and administrative burdens for the offshore asset management industry, which already has quite a lot to do in getting its funds in shape to meet the rules.
The second issue goes back to the breadth of the funds that might be caught. The offshore funds tax regime does not comply with the UKs obligations under agreements that create the European economic area. Previous legislation linked the definition of offshore funds to the regulatory definition, as in sections 235 and 236 of the Financial Services and Markets Act 2000, and was unlikely in practice to apply to mainstream retail investments. However, the proposed definition set out in schedule 22 appears to bring a far greater range of investments within the definition of an offshore fundthat was the comment I made in the first part of my remarks about trying to have greater clarity. The definition is so broad that the question of the regimes non-compliance with EC law arises in practice.
I have been given the following example, in which a UK bank offers, as a retail investment,
a debt security which redeems at any time after a minimum holding period of, say, 12 months by reference to the FTSE 100 (though any chargeable asset, or index of chargeable assets, for capital gains tax purpose would provide the same result).
In the absence of complicating factors, such an investment should be regarded as a capital gains asset for tax purposes, with any gains, made on disposal of the investment subject to tax at 18%. The offshore funds rules will not apply because the mutual fund is constituted by a UK resident company.
However, if the same debt security is
issued by a French or a Luxembourg financial institution under the proposed new definition,
that definition is sufficiently broad to cause that identical investment to be subject to different rules, which would result in any gains being treated as income and therefore taxed at the higher rate. Therefore, if the Government introduce their plans for a 50 per cent. tax rate, those gains could be subject to tax at that rate, whereas the same security issued in a UK resident fund would be taxed as capital gains at 18 per cent. There appears, therefore, to be a difference between UK issuers of investments and non-UK issuers of investments, which constitutes discrimination. That, it is argued, then constitutes a restriction in the free movement of capital from UK resident investors to financial institutions resident in other EEA member states, which would be unlawful. I would be grateful if the Minister could comment on whether the Treasury believes that that differential treatment renders the rules in breach of EU law.

Ian Pearson: Schedule 22 is in two parts. The first part deals with a new definition of an offshore fund for tax purposes and the second part deals with the capital gains tax treatment of participants in certain offshore funds. The hon. Member for Fareham has concentrated on the first part, and, as I think that we agree on the second part, I will not specifically refer to it.
As the hon. Gentleman knows, following extensive consultation last year the Government introduced powers, in the Finance Act 2008, to modernise the offshore funds tax regime. At that time, we said that we would consult further with industry on a new definition for offshore funds, with a view to including that in the Finance Bill 2009.
Additional consultation has led to the inclusion of a new offshore funds tax definition, in part 1. With the new offshore funds tax definition, the Government aim to provide more certainty to UK investors and funds; to achieve, to the extent possible, economic parity with the position of UK investors in UK-authorised funds; and to strengthen existing anti-avoidance rules so that UK investors who choose to invest in offshore funds do so based on a commercial decision, rather than for tax purposes. The new definition uses a characteristics-based approach, which the hon. Gentleman referred to. That aims to counter unintended tax advantage being obtained when offshore arrangements are technically outside the current definition of an offshore fund but are economically the same as such a fund.
I shall now turn briefly to the substance of the schedule, before responding directly to some of the hon. Gentlemans questions. Paragraph 40A defines the type of body that will be an offshore fund if it meets the characteristics defining a mutual fund. Paragraph 40B sets out three conditions that must be satisfied for a fund to be a mutual fund. There are powers to make regulations to amend the third condition, using the affirmative procedure. In addition, certain closed-ended entities are excluded.
Exclusions apply for those investors in closed-ended entities who can effectively redeem their investment only on the winding-up of the arrangements. Those exclusions are applicable when either the arrangements have no pre-determined termination date or are only generating a capital return and do not give rise to any income, or when all income generated is paid to credit to the investor and is taxed as income. The powers in this part allow for future changes to the legislation by regulations, and the Government will continue to monitor the area for avoidance and will use those powers if it becomes evident that schemes are being devised to convert returns that would otherwise be income into capital gains. The Government will also be prepared to make changes in the future if it is clear that certain arrangements should be excluded from the tax definition.
This part also amends the regulation-making powers introduced by the 2008 Act to repeal the existing offshore tax funds legislation and to ensure that existing investors in arrangements that do not meet the current definition of offshore funds are not adversely impacted by the change. We have made draft regulations available to the Committee, and they set out certain exceptions for UK investors from the tax charge to an offshore gain.
The hon. Gentleman made some points about guidance. As he knows, the guidance has been published by HMRC as a draft for consultation and is based on the offshore funds definition. I confirm that further guidance will be published on the operation of the rules. HMRC is happy to make the guidance clearer, following consultation responses on specific issues.
It is also right to emphasise the Governments position, which is that we believe that there is no discrimination here with regard to the treatment of schemes and how they comply with EU rules. We intend to treat investors in funds that provide taxable income to investors as authorised UK funds in a similar way to investors in UK-authorised funds. So there is no discrimination.

Mark Hoban: I am grateful for the Ministers comments about the compliance with EU law, but does he believe that, in the example that I gave, where a UK bank officer reads as a retail investment a debt security that redeems at any time after, say, a minimum holding period and that return is subject to the movements of the FTSE, for example, which is not dissimilar to condition C in new section 40B, that return would be treated as income? The industry believes that that would be treated as a capital return and taxed at 18 per cent., not at the investors highest rate of income tax.

Ian Pearson: I do not want to be drawn into commenting on specific examples and giving rulings on them. I want to rest on the fact that we believe that what we are doing is compliant with EU law. Having heard what the hon. Gentleman says with regard to industrys concerns about the treatment, I will see whether I can clarify matters, whether through correspondence or other routes.

Peter Bone: What practical steps do the Government take in relation to the general issue of compliance with EU regulation? Do they go off to somewhere in Europe with the draft Bill and say, Is this okay? Does it tick the boxes? Or is it solely opinion from here? What consultation goes on with Europe?

Ian Pearson: As the hon. Gentleman is aware, extensive financial and legal expertise is available to the Government. When drafting legislation, the experts are aware of EU law that is extant in this and other areas. When drafting legislation we always seek to ensure that it will be EU-compliant.
The policy is to exclude partnerships where they are tax-transparent for both income and capital gains purposes. If we receive representations saying that certain partnerships are included in the definition but should fall outside it the Government will be happy to address that in regulation.
On debt securities issued by EU institutions, debt will not be treated as a participating interest in an offshore fund, unless it gives the right to participate in profits. That point is addressed in the extract of regulations previously provided to the Committee. I am more than happy to provide, in correspondence, further clarification, if it is required, on the specific point raised by the hon. Member for Fareham.

Question put and agreed to.

Schedule 22 accordingly agreed to.

Clauses 45 and 46 ordered to stand part of the Bill.

Schedule 23 agreed to.

Clause 47

Equalisation reserves for Lloyds corporate and partnership members

Question proposed, That the clause stand part of the Bill.

Mark Hoban: The clause has found widespread support within the insurance sector. There was a differential in the tax treatment of equalisation reserves between conventional insurance companies and those people who participated at Lloyds, particularly the corporate partnership members. The clause tries to address an important issue that has emerged over the past couple of years: for a certain group of reinsurers, it has become increasingly more attractive, for tax and regulatory reasons, to move their redomicile activities from the UK to Bermuda. The clause should help to redress some of the competitive issues. Will the Minster say a little more about what else the Government are doing to address the competitive challenge that exists in reinsurance, because London has been seen as the primary insurance market? Lloyds has a strong brand globally and is an important part of our financial services sector, but there has been that shift from London to Bermuda, and several people have questioned whether the Government are doing enough to reverse that move.

Ian Pearson: The hon. Gentleman is absolutely right that that provision has been welcomed by the reinsurance industry, which has certainly been pressing us on this for a considerable time. The clause will put in place Treasury power to make regulations that will extend the benefit of tax relief on making equalisation reserves to corporate and partnership members of the Lloyds insurance market. He is right to point out that general insurance companies currently benefit from relief when they are required by the Financial Services Authority, as the insurance regulator, to make equalisation reserves, but Lloyds members are not required to do so. Essentially, we are seeking to level the playing field, and that has been welcomed by Lloyds.
The regulationsa draft is available to the Committeefollow the existing rules that apply to general insurance companies and are suitably adapted to grant tax relief where Lloyds members choose to maintain notional reserves equivalent to the equalisation reserves maintained by general insurance companies. The clause increases fairness and helps the competitiveness of the UK insurance market.
More generally on competitiveness, the hon. Gentleman will be aware that groups take into account a range of factors when reviewing their domicile, including regulation and its effect on credit ratings, the availability and quality of local staff, professional support services, infrastructure and also tax. We believe that London shapes up well as an attractive environment and a world-leading, professional centre with support and an unsurpassed insurance industry presence and experience.
The UK corporate tax burden compares favourably with those of similarly developed countries. Luke Savage, the finance director of Lloyds, has expressed strong support for the measure, which is expected to make a significant difference to members tax bills and improve Lloyds market competitiveness compared with other general insurers. That addresses the hon. Gentlemans point about Bermuda and other jurisdictions. The Government will always want to keep these matters under review, but the clause has been welcomed by Lloyds and the industry. We are acutely aware of the need for a competitive regime, but tax is not the only consideration.

John Pugh: Does the Minister recognise that Bermuda, like the Cayman Islands, is a Crown dependency and that there is unfinished work to be done? It is not just a question of making a competitive environment; it is about doing something about a regime over which we have some control.

Ian Pearson: I accept the hon. Gentlemans point. He will be aware of the work being done on tax havens and other jurisdictions, and of the extensive amount of work involved in insolvency. It is important that we, as a Government, continue to work closely with the industry to discuss the impact of the proposed solvency II changes, and the competitive position more generally, and to take appropriate action where needed to ensure that the UK maintains its pre-eminent position in the worlds insurance markets.

Question put and agreed to.

Clause 47 accordingly ordered to stand part of the Bill.

Clause 48 ordered to stand part of the Bill.

Schedule 24

Disguised Interest

Jeremy Browne: I beg to move amendment 176, in schedule 24, page 233, line 16, leave out 485B and insert 486B.

Jimmy Hood: With this it will be convenient to discuss Government amendment 159.

Jeremy Browne: I shall be extremely brief. We sometimes have debates by proxy through various interest groups that are knowledgeable in a field making representations to the Government and Opposition. Amendment 176 was suggested by the Chartered Institute of Taxation as a more preferable form of drafting. I want to give the Minister the opportunity to consider what seems to be a reasonable representation and to find out whether he concludes that the proposal is superior to the current drafting.

Stephen Timms: Welcome back to the Chair, Mr. Hood. I would like to say a few words about clause 48 and schedule 24 before responding to the hon. Gentlemans amendment.
Current tax law contains targeted anti-avoidance rules to ensure that amounts economically equivalent to interest are charged corporation tax in the same way as interest, instead of in a lower tax way. Clause 48 and schedule 24 replace those piecemeal measures with a rule that sets out the principle comprehensively. It is the result of consultation over the past couple of years on the use of principles-based legislation to tackle avoidance involving disguised interest. Subject to some exclusions, a return equivalent to interest will be charged to corporation tax as interest in all circumstances where it would not currently be taxed as income.
The schedule ensures that companies party to arrangements that produce interest for them in a disguised form are subject to corporation tax in the same way as if they had received actual interest. It replaces a range of targeted rules with the comprehensive rule that I have described, which charges companies corporation tax on all returns equivalent to interest in the same way as on interest, unless a specific exemption covers the returns. There are specific exceptions for arrangements where it is reasonable to assume that avoiding corporation tax is not the main purpose, or where the return simply results from an increase in the value of certain shares held by the company.

Mark Hoban: One of the representations that we received from outside bodies was about the phrase
it is reasonable to assume
in proposed new section 486D(1). The concern is that that is a subjective test, whereas normally a much more robust test is used for anti-avoidance measures. In such cases, the principal purpose is to avoid tax, and that is demonstrable. Here, Inland Revenue or Her Majestys Revenue and Customs might think that it is reasonable. However, others might disagree about whether it is reasonable to make such an assumption. Will the Financial Secretary give some clarity as to why that wording was chosen, particularly as it was not the wording in the original drafts that were consulted on?

Stephen Timms: There certainly has been some interest on this point, as the hon. Gentleman says. Tax legislation already uses the words reasonable to assume in a wide variety of contexts, and HMRC has taken legal advice on legislation containing those words on several occasions. However, the advice would not have relevance to disguised interest legislation because of the different context.
The words in the schedule are words of limitation and would be interpreted as such by the courts. In practice, reasonable to assume will only rarely make a difference to the way in which the test is applied, since an unsupported assertion as to purpose would, in any case, not be accepted by HMRC as establishing true purpose, if objective evidence pointed to the contrary. Any tax avoidance test based on purpose already implicitly contains a reasonable assumption requirement. The wording in the schedule simply makes that fact explicit. We have thought about this point and discussed it with several outside organisations. We think that it is helpful to have the words for clarity.
There has been extensive consultation on that narrow point and also on the wider point of using principles-based legislation to tackle avoidance. The aim of such legislation is to stop avoidance activity in the area concerned and to allow the repeal of traditional legislation that sets out a series of detailed conditions to be met before the legislation can apply.
The traditional approach can, in effect, allow avoidance, because taxpayers can seek to sidestep the detailed conditions. It is much more difficult to sidestep an approach based on a comprehensive principle with exceptions built in. We are turning around the way in which the legislation operates, and we think that that approach will be more effective. There has been a great deal of discussion about it.
The new legislation allows the removal of 30 pages of existing detailed anti-avoidance legislationit will be replaced with the 11 pages hereand signals that we think that the principles-based approach, which has been widely discussed, can be made to work, and that we will in future consider its use in appropriate areas of legislation as a means of tackling persistent attempts at avoidance.

Mark Field: The Financial Secretary has gone into detail about some of the thinking here. Is he not concerned that the spirit of the age, whether on tax law or the law as a whole, is much more towards certaintyin other words, having deeper rules in a much broader contextrather than a principles-based approach? One of the concerns in what will inevitably and continuously be a competitive world, where we try to attract the best brains and businesses to our shores, is that the lack of certainty in the principles-based approach is likely to be detrimental to the better interests of this country.
I can see that there are great benefits from the Treasurys point of viewthe Financial Secretary made that explicit. In effect, he is suggesting that most avoidance schemes will be disallowed at the outset unless they can be shown to have properly sidestepped from the purposes of the Treasury, but the lack of certainty that a principles-based system brings can surely only be detrimental to the better interests of this country.

Stephen Timms: I suggest that our approach gives greater certainty. The problem with the old approach was that legislation set out that taxpayers could not do this, that or the other. It was pretty straightforward for people to devise slight variations on what was being prevented and then to argue they could carry on doing it. That created a fair amount of uncertaintyand certainly a lack of clarityabout the position. With this approach, however, the position is absolutely clear: if it really is interest, the tax needs to be paid on that basis. The arrangement is pretty clear and certain.
The disguised interest rules apply where a company is party to an arrangement that produces a return that is economically equivalent to interest. There are some exceptions, which are clearly set out. I do not agree that such an approach produces uncertainty; if anything, the reverse is true. We have had an interesting debate on principles-based legislation. This clause and schedule and the next clause and schedule embody that approach, which is, in a sense, experimental; it has not been tried before. The intention was to legislate in last years Finance Bill along those lines, but the representative bodies argued that we should take longer, because it was a significant departure from how we legislated in the past. We have been able to resolve the concerns about the principles-based approach, which I think is a good one, not least from the point of view of certainty.
The hon. Member for Taunton explained the background to amendment 176. He is absolutely right: there was an error in the schedule as drafted. We spotted the error, I am pleased to say, and it has been accepted as an error to be corrected as a matter of printing. Nevertheless, I am grateful to him for tabling his amendment and drawing attention to the error in that way.
Government amendment 159 also corrects a typographical error, but one that cannot be dealt with as a matter of printing. The error, which is in the transitional rules, would have the effect that certain types of arrangement already in place on 22 April 2009 would be excluded inappropriately from the scope of the legislation. The amendment corrects the error and ensures that the disguised interest legislation can apply to such arrangements. The amendment has effect from Budget day, on the basis that the legislation was widely consulted on before the Budget using drafts that did not include either of the errors. It can affect only transactions that were already in place on Budget day and were caught by existing anti-avoidance legislation.
I am happy to accept the hon. Gentlemans amendment and commend the Governments to the Committee.

Amendment 176 agreed to.

Amendment made: 159, in schedule 24, page 243, line 9, leave out 14 and insert 15.(Mr. Timms.)

Schedule 24, as amended, agreed to.

Clause 49 ordered to stand part of the Bill.

Schedule 25

Transfers of income streams

Stephen Timms: I beg to move amendment 178, in schedule 25, page 247, line 6, after taxed), insert
(aa) section 809AZCA (certain annuities),.

Jimmy Hood: With this it will be convenient to discuss Government amendments 179 and 180.

Stephen Timms: The second example in the Bill of the use of principles-based legislation, the schedule secures that receipts that derive from a transfer of a right to income are treated as income for the purposes of income tax and corporation tax. Like the measure on disguised interest, it is the result of consultation on principles-based legislation.
Case law shows that it is possible for companies and individuals to convert income into capital for tax purposes by selling the right to income streams. For individuals, such schemes are particularly attractive as a result of the capital gains tax increase to 18 per cent. Avoidance in this area has led to a wide range of piecemeal measures that treat sales of income as giving rise to amounts charged to tax as income. The schedule replaces the various targeted anti-avoidance rules with a comprehensive rule that ensures that a company or individual cannot avoid tax by selling income for a lump sum that is taxed more favourably than the income would have beenfor example, a capital gain covered by losses.
As a result of the consultation, schedule 25, like the preceding schedule, contains specific exceptionsin this case, for transfers of income that are the consequences of the transfer of the asset from which the income arises, or where a transfer of income is the consequence of the grant or surrender of a lease over land. There are also exceptions for disposals of rights in respect of oil licences. The new legislation saves 15 pages of anti-avoidance legislation, using only eight pages, and is another example of the principles-based approach being made to work.
The Government amendments correct an error in the schedule, which replaces a number of enactments. Among the repealed provisions is a rule that currently taxes the sale of the right to annual payments as incomethat is, recurring payments of an income nature that are paid under a legal obligation. That repealed provision contains a number of exceptions for sales of annual payments that are already subject to appropriate tax treatment. Owing to an oversight, the new transfers of income rules do not replicate those exclusions, but they should have done. Without the amendments, the new rules could impose an additional and inappropriate tax charge on transactions of that kind, so they simply restore the exclusions and make sure that they continue to apply under the new legislation.

Peter Bone: Is not the Financial Secretary making the case against principles-based legislation? Instead of laying down things that one knows are wrong and saying that they must not be done, the principles-based approach sets out a principle that is thought to say what things are wrong, but can catch things that are perfectly acceptable. Is not the Minister outlining that in this exemption? Is not that the problem that principles-based legislation creates?

Stephen Timms: No, I do not think it is necessarily a problem. It is perfectly possible, with the new approach, to set out clearly things that are excluded, and that is what we are doing. The hon. Gentlemans description highlights the difficulty with the old approach. If one sets out in legislation things that people are not allowed to do, it is not difficult for them to come up with a slight variation that they will do instead. The disguised interest rules that we were talking about a moment ago were introduced in 2005, but it has been necessary every year to amend them to capture the new things that people have come up with. I hope that annual amendments will not be required under the new approach.

Peter Bone: But again, I think the Minister is making my point for me. Yes, the approach favours the Revenue in catching more avoidance, but it is catching innocent taxpayers as well. Under the previous approach, we said that something was definitely wrong and, yes, it had to be updated every year, but taxpayers who were acting innocently were not caught by it, whereas the new approach will capture people whom the Minister has not realised should be exempted, so he will have to introduce more and more exemptions each year.

Stephen Timms: I do not agree. It is important that we get the exceptions right and set them out clearly and correctly, which the amendments will help us to do. However, I do not agree that the approach we are adopting needs to catch people who are doing perfectly proper and innocent things. Of course, if an exception is subsequently drawn to our attention, it will be perfectly possible to include it, but I do not think we will be in the position of having to make annual changes, which was the position under the old approach.

John Pugh: There is an obvious analogy with the Green Book on Members expenses. That had to be rewritten every year, but we have now moved to a principles-based decision-making procedure. The only problem with that is that it will lead to some post-hoc judgments being made that might not be favourable.

Stephen Timms: The hon. Gentleman draws an interesting and perhaps illuminating analogy to assist the Committee in its deliberations.
I think that the approach we have chosen is right. This is something of a pilot and we will need to see how it goes, but the work has so far shown that it is a promising approach that we can perhaps make more of in the future. I commend the amendments to the Committee.

Mark Hoban: Given that the Financial Secretary made some broader remarks about the schedule, perhaps it is appropriate for me to make some comments about the schedule and ask one or two questions.
On the principles-based approach and the breadth of the schedule, I understand the problem that the Minister wants to avoid of having to make annual changes to legislation and introduce more exceptions to capture different types of transaction. However, my hon. Friend the Member for Wellingborough put the alternative case on the breadth of the schedule and what sort of transactions it actually covers. Are we certain that swapping narrow rules for a broader-based approach is the right way to go?
An example has been raised with me that illustrates the problem that the Government are facing and the issue that my hon. Friend has discussed. Throughout the consultation process, the policy focus of this part of the Bill was on the corporate sector. There was no suggestion that the rules in the Bill would be applied to individuals to any appreciable extent. However, in the drafting, it is necessary to include in part 2 the words
a person within the charge to income tax,
in contrast with
a company within the charge to income tax,
which is referred to in part 1. The wording in part 2 captures non-resident companies that are not carrying on a trade in the UK through a branch or an agency. I understand the point of having that, but the suggestion has been made that for individuals, arrangements that divert income to another party are likely to be caught by settlement legislation. IR35the managed service companys rulesalso apply where income from personal services is concerned.
Although the Government have said that, as a consequence of the Arctic Systems ruling, there has been some consultation on income shifting, in the Budget it was suggested that such measures would be deferred. There is concern about whether the provisions of schedule 25 are drafted widely enough to be capable of catching transactions or arrangements under which turnover generated by an individuals personal activities can be passed to another person and caught by the income shifting rules that, so far, the Government have not sought to introduce. That goes back to the question of breadth. Although it is not the intention or the policy objective to capture individual arrangements, the breadth of the schedule allows them to be caught.
The Financial Secretary might say, by way of clarification, that the schedule is not intended to capture individual arrangements, and such a statement would be welcome. However, the concern is that any statement to that effect made in this Committee would not have the weight in court that it should have, because there is no ambiguity in the schedule. I would be grateful if he clarified whether the schedule is intended to capture income shifting between individuals. If it is not, how can it be amended on Report to put it beyond doubt that it is not a backdoor way of introducing the rules on income shifting that the Government decided to put on hold?
I also want to discuss how the rules will interact with other parts of tax law and what the priority should be. For example, the CIOT representation states that rules on loan relationships, derivative contracts and intangible fixed asset regimes should take priority over the transfer of income rules. There is also no specific provision on the interaction of these rules with capital gains tax rules. Clarity on that would be helpful.
However, the main issue that the Financial Secretary must tackle is whether the transfer of income streams between individuals will be caught by these provisions. If they are not intended to be caught, he should say how we can clarify that through amendment on Report.

Stephen Timms: It certainly is possible for individual transfers of income to be caught by the provisions, and deliberately so. Under the new arrangements that the Committee has debated, people could obtain a tax rate of 18 per cent. rather than 50 per cent., which is the new higher rate of income tax. Therefore, individuals do come within the schedule. However, on income shifting, I reassure the hon. Gentleman that the provisions will not be applied in situations such as the Arctic Systems case. That case involves a different type of transaction whereby income is allocated tax efficiently between two or more parties. As a result of the ownership of the asset from which the income arises, that case does not involve the transfer of a right to income. Therefore, the legislation will not apply in that case. What the schedule deals with does not happen in cases such as Arctic Systems, because there is no transfer of a right to income.

Mark Hoban: Clearly there is some disagreement between the Treasurys interpretation of the schedule and that of the Law Society and others. Is it not possible to put the matter beyond doubt by introducing an explicit exclusion for income that is transferred as a consequence of a performance of personal services, for example?

Stephen Timms: I think that the matter is beyond doubt, but I will happily look at it again and reflect on the hon. Gentlemans point.
The hon. Gentlemans second point was about capital gains tax. If the consideration is charged as income under the transfer of income rules and the transferor realises neither a capital loss nor gain on the part disposal of the asset, but is able to carry forward the whole pool of capital expenditure to deduct on a subsequent disposal of the asset, that outcome is reasonable because the whole amount of capital expenditure remains available when the asset is sold. If the asset is subsequently sold for a capital loss, that loss cannot be set off against the taxable income that previously arose, but that outcome is not unreasonable, given that it is within the transferors power to avoid that outcome by selling the asset rather than just the income.
I have been reminded, Mr. Hood, that the guidance on Arctic Systems and income shifting cases of that kind does make the position clear.

Amendment 178 agreed to.

Amendments made: 179, in schedule 25, page 248, line 15, at end insert
809AZCA Exception: certain annuities
This Chapter does not apply to a transfer of a right to
(a) annual payments under a life annuity as defined in section 473(2) of ITTOIA 2005, or
(b) annual payments under an annuity which is pension income within the meaning of Part 9 of ITEPA 2003 (see section 566(2) of that Act)..
Amendment 180, in schedule 25, page 250, line 32, at end insert and
(i) in CTA 2009, in Schedule 1, paragraphs 214 and 230..(Mr. Timms.)

Schedule 25, as amended, agreed to.

Clause 50 ordered to stand part of the Bill.

Schedule 26 agreed to.

Clause 51 ordered to stand part of the Bill.

Schedule 27

Remittance basis

Question proposed, That the schedule be the Twenty-seventh schedule to the Bill.

Mark Hoban: Hon. Members may have been thinking that they were just going to breeze through schedule 27 and clause 52 of the Bill. Having spent a day last year in Committee debating the way in which the residence and domicile rules were going to work in practice, I feel this could not pass without some comment. Many of the questions about the function of these rules that hon. Members raised in Committee on last years Finance Bill have come back to haunt the Government and have led to the changes that we see in this Bill. We raised a number of questions about the filing of returns, the de minimis limit, trading, spouses and property, all of which are dealt with in this part of the Bill.
The first question I want to raise relates to the
application of the remittance basis without claim where unremitted foreign income and gains are under £2,000.
That change in the Bill means there is now no requirement to file a return where gains are less than £2,000, which is to be welcomed. At the time the matter was raised, we flagged up our concern that to file such a return would be significant burden on HMRC and the taxpayer. However, in clause 52, the rules are amended to introduce a de minimis limit of £10,000, so what happens now? Is someone with foreign income of less than £10,000 still required to file a self-assessment claim, or does the £2,000 limit apply in such a case?
It is important to have clarity on that point, because there is a large number of people who work here temporarily who may have some foreign income from overseas. We discussed the large number of migrant workers last year, and my hon. Friend the Member for Hammersmith and Fulham, who is not in his place, cited the example of Polish workers in the UK who might have some residual income, say from a flat they have back in Polandrental income or other interest.

The Chairman adjourned the Committee without Question put (Standing Order No. 88).

Adjourned till this day at One oclock.